"The potential returns from fixed income have increased significantly from a few years ago," says Janet Salter, Vice President and Portfolio Manager at Portfolio Solutions Group (PSG), a division of Canada Life Investment Management
This article was produced in partnership with Canada Life Investment Management
The volatility in fixed-income markets in recent years prompted many investors to pivot towards safer, cash-like investments. This reactionary shift was understandable but, as recent developments suggest, perhaps premature. The Bank of Canada's efforts in reducing inflation and the anticipated rate cuts by the end of 2024 signal a changing tide that underscores a vital investment lesson: investors should have considered staying in fixed income.
The resurgence in fixed-income investments has been supported by the stabilization of interest rates by central banks across Canada and the United States. In these times, when market noise often obscures clear decision-making, understanding how to effectively reintegrate fixed income into investment portfolios is paramount. Salter found that much of 2023 was spent highlighting the value and intricacies of bonds.
Addressing the broader economic context, Salter noted, “We're at a juncture where the risk-return profile of fixed income is increasingly favorable.” The stabilization of rates has predictably reduced the volatility that previously deterred fixed income investment, providing a clearer outlook for potential returns. “Interest rates and returns have become more predictable, making fixed income a viable asset class once again,” she explains.
Portfolio allocation
Since interest rates have increased, there's now a beneficial aspect at play for fixed income investments: a yield cushion. This cushion provides some protection against potential losses if interest rates continue to rise.
Essentially, the higher initial yields can help offset the negative price movements that typically occur when rates climb. This kind of buffer hasn't been seen for quite some time, offering a renewed strategic advantage in managing fixed-income assets amidst fluctuating interest rates.
Salter highlights, “Fixed income currently faces fewer headwinds and offers better risk mitigation than other asset classes. There's still uncertainty, of course, but from a risk perspective, fixed income has more tailwinds. We also prefer to maintain an overweight stance in credit products, reflecting our bias towards these investments. Within our fixed income allocations, we heavily rely on the active management expertise of our fund managers. They are adept at tactically positioning their portfolios to capitalize on opportunities in the fixed-income markets.”
With global markets in flux, PSG's strategic allocation to global fixed income is crucial. Salter details the approach, saying, “Our global fixed income exposure, whether through public or private markets, is carefully calibrated based on the interaction between domestic and global bonds.”
The education component
A significant part of Salter's strategy considers the benefits and functions of fixed income. She points out that despite the past periods of low returns, fixed income should remain a staple in diversified portfolios.
Bonds aren’t like equities. With equities, when the price of stock rises, it is clear and straightforward. However, there is an inverse relationship between bond prices and yields, which can lead to confusion. Often yields are discussed, but the actual focus should be on total return.
If an investor buys an equity product at $10 and it rises to $20, the increase is easily understood. In contrast, if a bond's price drops from $100 to $90, it might initially appear as a loss. Yet, what is often overlooked is that the yield has become much higher, which is beneficial.
“Even before the recent shifts, I’ve been highlighting the fundamentals of bonds. Starting last September, I emphasized the key principles – such as bond duration and how rising yields can negatively impact prices, yet you still receive the coupon.”
“The goal is to clarify that returns are not symmetrical and is also some predictability. This understanding is crucial, especially when considering that in the past 71 years, in Canada we only experienced two back-to-back negative fixed income returns,” Salter says.
Looking ahead
Salter emphasizes the importance of staying informed and agile to manage the changing market dynamics effectively. “The fixed-income market has seen significant changes, but with central banks providing a more predictable path forward, we can navigate these with greater confidence,” she remarks.
“We have seen historical negative returns, like those in 2021 and 2022, with 2023 initially appearing to follow the same trend. However, everything changed in the fourth quarter of 2023.”
This underscores the saying that ‘time in the market is better than timing the market.’ It's a perfect example of how one might have given up on fixed income until October of last year, only to see it rebound dramatically. Returns are becoming more stable and predictable.
Want to get more insights from Portfolio Solutions Group?
Canada Life Investment Management Ltd. brings together leading investment managers to offer a relevant and diverse fund line-up that meets your client’s needs through today’s changing market dynamics. Read the latest back to basics thought leadership series by PSG that highlights some of the fundamentals of investing and how they’ve contributed to PSG performance.
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Disclaimer:
The views expressed in this commentary are those of this investment manager as at the date of publication and are subject to change without notice. This commentary is presented only as a general source of information and is not intended as a solicitation to buy or sell specific investments, nor is it intended to provide tax or legal advice.
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